At Vulpes, most of our time is spent on the Governance component of ESG. In part, this means looking deeper into how companies identify and internalize externalities into business models and take advantage of the bigger trends and opportunities.
Rather than a long piece, this is set to be the first of several on the subject.
Long term thinking
Sustainable investing requires an emphasis on the longer term. Unfortunately, this outlook is not always available for larger listed companies. The average CEO tenure for the Russell 3000 was less than 7 years and for the S&P500, less than 8 years as of 2017. Both of these have actually fallen in recent years.[1] Furthermore, CEOs face several short-term pressures including meeting quarterly targets, let along annual ones.[2]
For institutional investors, this pressure can be even greater. Some Chief Investment Officers face monthly performance pressures or risk losing assets under management, making their businesses unsustainable. Accordingly, incorporating longer term considerations can be difficult. Like CEOs, CIO tenures are short, with an average of 6 years in a recent CFA Institute survey.[3]
In contrast, the nature of family office investing is long term: while there can be different styles, assets need to be resilient in order to be passed to the next generation while family legacy and reputation matter.[4] Therefore, even though some climate risks can be far in the future, these can be tackled in multiple ways. For example, given emerging freshwater risks,[5] we can look to reduce water use and take a more holistic approach even though there is no short term price pressure to do so. Alternatively, there are also early-stage technology investments with future potential payouts.
Material Issues and the Box Tick
Like some investors, we don’t find aggregate ESG scores particularly useful in helping us understand if an investment is “sustainable”. Overall scores are far too noisy and may even be questionable from a baseline perspective. However, data on specific issues can be very useful. Importantly, idiosyncratic considerations mean one variable or material issue can override all. For example, in one of our positions, keeping with the water theme, this ecosystem service is by far the most critical issue. If we get water wrong, the position could easily fall in value by over 50% or even become stranded. We can get many other things wrong and still barely lose any value.
Furthermore, at the “G” level, while quantitative metrics can matter, they can sometimes mislead too. One example is “Diversity” which we see as an economic necessity and opportunity. Some context helps. The UK House of Commons recently published data on Women and the UK economy.[6] The female employment rate was reported at over 72% at the end of 2022 compared to below 60% in the 1980s. The gender pay gap remains at over 8% but was at17% in 1997. There is clearly an enormous amount to do still but what is clear is that with more women in the workforce and narrower pay gaps, the growth driver of incomes is women. Furthermore, there are strong arguments why this group will continue to be a growing force in consumer behaviour and capital allocation. The detailed UK data is useful and we think indicates a powerful global trend that is set to continue, including in developing economies.[7]
Therefore, what is needed is company management that maximizes this market opportunity.[8] In the UK, after the initial pushback by investors,[9] almost 40% of Board members in the FTSE100 are women from 12.5% in 2012. On the surface, this is good. But, at the same time, in a recent blog,[10] Professor Miriam Marra points out that women comprise only 8 of the 100 CEOs and 16 are Chairs of Boards. Given the market opportunity, and other data and studies, these numbers look too low.
In short, rather than ticking a box, we need to see through the data to identify if the right structure, incentives, skillsets and leadership are in place, whether to address material issues or develop new business strategies. The data needs to be rich enough, qualitative where necessary, to be fit for purpose in assessing if an investment is resilient and positioned to deliver excess returns.
This requires a greater emphasis on Governance, which is broad and complex. And this complexity needs to be embraced. In coming weeks, we will further elaborate on the building blocks that drive our thinking on what constitutes good Governance.
[1] https://corpgov.law.harvard.edu/2021/01/15/ceo-succession-practices-in-the-russell-3000-and-sp-500/
[2] See the CFA Institute report: https://www.cfainstitute.org/-/media/documents/article/position-paper/CFA-SHORT-TERMISM_Web.pdf
[3] See exhibit 10, https://www.cfainstitute.org/-/media/documents/survey/FoW_Skills_and_Learning_Online.pdf Interestingly, this same survey reported the average tenure of 20 specific roles, none of which were entitled Sustainability. Maybe its too recent a role as the topic is discussed in length in the report.
[4] A useful book on this issue is “Empire of Pain” by Patrick Radden Keefe
[5] See https://www.pik-potsdam.de/en/news/latest-news/planetary-boundaries-update-freshwater-boundary-exceeds-safe-limits and https://siwi.org/latest/landmark-report-water-is-critical-to-avert-a-climate-disaster/
[6] https://researchbriefings.files.parliament.uk/documents/SN06838/SN06838.pdf
[7] https://www.imf.org/en/Publications/fandd/issues/2019/03/closing-the-gender-gap-dabla
[8] With greater education attainment and fewer children, we would think over time as the cohorts age, pay gaps between older men and women would narrow further too.
[9] https://www.theguardian.com/business/2015/oct/12/fund-managers-women-boards-survey-finds
[10] https://research.reading.ac.uk/research-blog/effective-womens-power-in-corporations/